Sleepwalking towards the fiscal cliff
The time has come again when Congress pretends to walk off the fiscal cliff in exchange for some political concessions. As the US federal government passed its 31.4 trillion USD debt ceiling and the Treasury began invoking extraordinary measures to avoid defaulting on Treasury security debt, X-date approaches ever quicker.
The time has come again when Congress pretends to walk off the fiscal cliff in exchange for some political concessions. As the US federal government passed its 31.4 trillion USD debt ceiling and the Treasury began invoking extraordinary measures to avoid defaulting on Treasury security debt, X-date approaches ever quicker. Scheduled to occur at some point in the third quarter of 2023, it seems likely from remarks made by the United States Secretary of the Treasury Janet Yellen that X-date (when the debt ceiling is to be raised by Congress) will occur early June since that is when the Treasury will not be able to sustain its extraordinary measures.
Facing a Congress that took 15 votes to elect its House Speaker due to a complete and utter capitulation to the freedom caucus (far right house Republican caucus), it seems unlikely that raising the debt ceiling will be a smooth process. Furthermore, since most of the demands were related to spending cuts, it is not unrealistic to believe that the current kingmakers of the House, the freedom caucus, would shy away from the debt ceiling vote as a vehicle to implement their agenda. Gridlock is likely come X-date, and if the Treasury is unable to pay its obligations, the United States could plunge into economic chaos. Although defaulting is a possible outcome, two more likely outcomes would mirror what we saw in 2013 if we are lucky and 2011 if we are not.
In 2013, Republican House Speaker John Boehner, was unable to rally his caucus to vote for a debt ceiling increase in January resulting in a crisis which ended with the passing of the Continuing Appropriations Act of 2014. Thanks to Federal Reserve chief Ben Bernanke market volatility was avoided by ensuring low interest rates to avoid chaos on Wall Street. Unfortunately, such an inflationary policy is no longer feasible due to roaring inflation for 21st century standards. On the other hand, a realistic worst-case scenario would resemble 2011 which began in December 2009 and ended in August 2011. This fiasco resulted in the United States credit rating being downgraded from AAA to AA+ by Standard & Poor’s and a market once more sustained by low interest rates. In both scenarios, as long as low interest rates can be maintained the market should pull through.
But what if your economy is suffering from abnormally high inflation and a slip into recession? Since the Federal is projected to increase rates by 25 basis points over 2023, it seems that they are prioritizing combating inflation and recession over a likely debt ceiling crisis. As such, other more obscure methods will have to be used to avoid default if X-date is passed. There are three options which have begun to gain prominence. The first is invoking the constitution as it is stated in Section 4 of the 14th Amendment that “The validity of the public debt of the United States […] shall not be questioned.”. Invoking the constitution, although a possibility, is unlikely to work since it is legally questionable and as such would be shut down by a conservative supreme court all else held equal. Then, there would be minting a commemorative coin worth what is needed to avoid a default. Although Yellen and the Biden White House decided against it in 2021, it is likely they might reconsider if in a tight enough corner. Thirdly, there is payment prioritization which I believe would be the most likely outcome since it seems to be the one already in action. The plan would have the treasury pay bondholders first to avoid a default on a technicality.
At the moment, House Republicans have been drafting a plan for payment prioritization which would probably leave services such as Medicaid and SNAP without funding as Republicans have been staunchly against them. This would likely exacerbate the cost-of-living crisis for the poorest of American society. In addition, the questionable nature of payment prioritization might be destabilizing to the bond market and the stock market by contagion.
Written by Antonio Brunetti